Bond

Wait, what is this? Selling in both ES and bonds? Surely you jest: after all money just goes from one to the other right? Bzzzz. Wrong.

Despite empirical evidence that someone big stepped an and bought the bejeezus out of Italian bonds yesterday ahead of the Bill auction, and despite Willem Buiter's warning that tomorrow's critical BTP auction will fail absent ECB intervention, some of our transatlantic colleagues were panning long-winded essays that it is supremely irrational for the ECB to even think it can control the Italian bond market because of X, Y and Z. We, on the other contend, that precisely because it is supremely irrational is why the ECB will do it. And now we have evidence that if nothing else (and we will know for sure next week if the ECB bought the bonds after the weekly SMP details are released over the weekend, as else it would show that the PBOC is actively buying Italy bonds in the secondary market). And in the absence of actual buying, yoday we get another view at just how the ECB thinks it can manipulate markets. From Dow Jones: "Moody's junking Ireland is of particular concern "as many market participants have more hope for the Irish recovery story relative to Greece and Portugal," says ING rates strategist Padhraic Garvey. "Moody's have a different view." Garvey also says that the ECB asked for prices of sovereign bonds Tuesday but "there was no evidence that the ECB actually bought peripheral paper." Translation- the ECB sends out a OWIC (Offers Wanted in Competition), and dealers are supposed to soil themselves knowing full well that even if Trichet does or does not bid, other dealers may. Game theory 101.

A year ago we discovered that several European countries only managed to squeeze into the Eurozone by misrepresenting their total debt courtesy of Goldman Sachs facilitated currency swaps which misrepresented the true state of said countries' finances. Yesterday it was revealed that at least one Spanish region had been openly lying about its economic performance and underrepresented its budget deficit by about 50%. Today we go deeper into the rabbit hole, after a WSJ report discloses that European banks 'may' have been openly and frequently lying by misrepresenting to others about the amount of third party demand at any given bond auction. Think of it as the same BS that a bulge bracket bank in the US will use to sucker retail momo investors into a hot IPO. "A European self-regulatory body is looking at whether that perennial optimism might have at times been misleading for investors in the European debt markets, according to people familiar with the matter. The International Capital Market Association, or ICMA, is examining whether banks have been improperly exaggerating the amounts of investor demand they are seeing in certain bond sales, including for debt issued by European governments, these people say." Where does the rabbit hole lead next: someone discovers that the Bid To Cover ratio in all US bond auctions over the past several years have really been 50% lower than represented publicly? As for Europe: does anyone believe anything coming out of that continent anymore following the whole Jean-Claude Juncker fiasco? The Eurozone and the euro are both doomed and everyone knows it. But all is fair in love and perpetuating doomed ponzi pyramids (which is not to say that the US is any better).

Willem Buiter, Citigroup's chief economist and former BOE policy maker, told reporters in London today that "the ECB will intervene on whatever scale is necessary to allow Italy to conduct its auction on Thursday. If the ECB doesn’t come in, the Italian bond auction is likely to fail. What we’re going to have is the ECB are going to be doing the heavy lifting." To anyone who watched the sharp move in Italian sovereigns, so reminiscent of central bank FX intervention overnight, Buiter's conclusion is all too obvious. As we reported, there were extensive rumors, and certainly validated by trading activity, that either the ECB or the PBOC or both, intervened in the Italian bond market to make sure today's Bill auction priced, which it did, but absent the reinforcement of the central banks could have very likely failed. What is amusing is that it was just last week that reporters were querying Trichet why the ECB's SMP bond purchasing operation had been all but abandoned. Well, here's your answer: JCT was simply preserving his dry powder for all the upcoming contagion casualties, such as Italy first, then everyone else.

Busy economic calendar with two notable bond auctions out of the US Treasury.

The much ridiculed "MLEC-type" bailout proposal of Greece, which contemplates the rolling of existing debt into a guaranteed SPV, and which was the European rescue deux ex machina for exactly two weeks, appears to have been pulled off the table, following the announcement by German Deputy Finance Minister Joerg Asmussen to Reuters Insider TV that "Germany has put a Greek bond swap back on the table as a model for private sector involvement in fresh aid for Athens." More: "The model put forward by some French banks is still a good base for discussions and we are currently working on this. But since rating agencies have signalled that they will consider modalities (such as) the French proposal as a selective default -- that means a rating event -- we can also put other options like a bond exchange on the table." he said, adding discussions would take place over the summer break. Translation: back to square minus one. And actually it is much worse, because if Asmussen is aware of rating agency policy, a debt exchange would most certainly qualify for an event of default. Which confirms our initial expectation from a month ago that there is nothing absent a complete loss of ECB credibility that can possibly transpire next, as the ECB realizes there is no way around accepting defaulted Greek bonds as collateral. The only question is what happens then: will the market, head currently deep in the sand, scramble upon the confirmation that the ECB emperor is naked, or will it continue acting as if nothing has changed yet again.

Well this was unexpected: the rating agencies, for years and years patsies of their highest paying clients, have suddenly found their conscience, if not religion, and adamantly refuse to bend long-standing rules which qualify the proposed Greek MLEC/CDO type rescue as an event of default. Per Bloomberg: "The rating companies have signaled the plan would trigger because it is being done to avoid default, so couldn’t be considered voluntary, and because investors would be worse off than by holding the new securities." The ECB is so confused by this intransigence and unwillingness to bend to the will of the criminal cartel that earlier today the ECB's Novotny was complaining to Austrian TV about this unexpected demonstration of independence: "Debt rating agencies are being much tougher on potential private-sector contributions to Greece's debt woes than in past bailouts, European Central Bank Governing Council member Ewald Nowotny said on Monday. "We are conducting a very difficult conversation with the ratings agencies," he said."This is what we have to try to find: a way that on the one hand certainly involves banks without having this lead to a default as a consequence," he added. "I also must say it strikes me that the ratings agencies are being much stricter and more aggressive in this European matter than they were, for example, in similar cases in South America. I think this is something we will have to think over." As a result of all this sudden uncertainty, Bloomberg now speculates that the ECB will have no choice than to flip flop on its own adamant position of isolating defaulted collateral, and accept Greek bonds even in an event of default: “The ECB cannot remove liquidity from the big Greek banks,” said Dimitris Drakopoulos, an economist at Nomura. “This discussion is a waste of time. The ECB is going to back down in the end -- what can they do?” he added."

As the table below demonstrates, the bond vigilantes are now eviscerating the belly of the US Treasury curve: the weekly percentage move higher in the 5 Year yield is now the largest...Ever. For those wondering if PIIGS should be renamed to PIIS following the brief rescue of G, perhaps it is time to officially rename it PIISA.

Today's 7 year auction capped a miserable week, in which the 2 and 5 Years auctioned off placed at very ugly terms, although none probably quite as ugly as today's 7 Year. The $29 billion QT0 priced at a 3 bps tail to the when issued, replicating yesterday's action, and pricing at 2.43%, the same as last month, but at a Bid To Cover of just 2.62, the lowest BTC since March 2010 when QE1 was ending and the future was unclear. And like during the past two auctions, the internals were decidedly ugly as Dealers had to take up 56.07% of the amount offered: the most since May 2009, when however the Direct bidder category was a non-factor. Indirects continued their trend of stepping away from all issuance and bought just 32.17% of the bond, the lowest since March 2009. Additionally the hit rate on the indirect bid was a whopping 86%. If anyone has figured out just how foreign banks will step in to fund US bond issuance, please let us know, because we are confused. And Dealers will not be all that excited to have to convert risk assets into paper yielding just over 2%, in the absence of the Fed's vacuum pump... Certainly not at these rates. Slowly, the realization that OT2 is not coming a week ago is starting to soak in as the Treasury complex is finally realizing that Gross was right all along. Exhibit A for the past statement: the performance of the 5 year in the past 3 days, whose 32 bps blow out is the 3rd biggest such move. Ever.

Following yesterday's very disappointing 5 Year $35 billion auction by the US Treasury, Germany followed up today with its own unsubscribed bond auction failure, after Germany sold just €4.825 billion in 5 year bonds at the 2011 low yield of 2.16%. The problem - the auction remained technically undersubscribed as the €6 billion offer only received €5.445 billion in bids. Even on a sugar coated basis, the BTC was just 1.1, a plunge from the 1.9s seen recently. But such is life without the backstop of Primary Dealers who buy up everything there is, until they themselves are no longer able to flip the shell game. From Dow Jones: "The Bundesbank said all bids at the lowest price were accepted and it satisfied all the non-competitive bids at the weighted average price. The amount retained for market-tending purposes was about EUR1.175 billion, bringing the total issue size to EUR6 billion, as previously announced." Bottom line, with the pristine economy of Germany unable to sell bonds, what does that mean for the US and the rest of the insolvent "developed" world?

Time to push out even more cash bond shorts:

In accordance with the Sovereign Credit Risk Framework and in response to the yield differential of 10 year Portuguese government debt and 10 year Irish government debt against a AAA benchmark, LCH.Clearnet Ltd has revised the risk parameters for Portuguese and Irish government bonds cleared through the RepoClear service.  The additional margin required for positions of Portuguese government bonds will consequently be increased to 65% for long positions.  The additional margin required for positions of Irish government bonds will be increased to 75% for long positions. These amounts will be adjusted for the current bond price*.  Short positions will pay a proportionately lower margin.

Stocks outperformed credit at the index level today but there was a significant shift in internals in corporate credit that provides the context for continued weakness in risk assets.

Today's 10 Year bond (CUSIP: QN3) priced at a solid 2.967%, just wide of the when issued 2.961%, the lowest high yield since November's 2.636% when QE2 was starting (in the form of POMOs, QE2 had long been priced in). The Bid To Cover confirmed the strength of the auction coming at 3.23, a jump from May's 3.00, and higher than the LTM average of 3.10. Indirect Bidders for the first time in 3 months surpassed 50%, taking down 50.6%, with Dealers allotted 41% and the remaining 8.3% going to Directs. Look for QN3 OTR to dominate POMOs over the next 2 weeks. Since there will likely be at most two more 10-year focused buybacks, Dealers will be able to promptly flip this bond to the Fed. As for next month, when the US is on the verge of a full blown default, it is unclear what happens.

Just in case the broad speculator public did not get the message earlier this week after the CME lowered ES margins, just in time for the market to sell off and send realized vol surging (while of course ignoring plunging vol in gold, silver and all other commodities), the CME has completed the "paint by Rahmian numbers" puzzle, and has made clear which other asset class has the investment "go ahead" by the administration. As of a few minutes ago, the initial and outright margins for 10Y and 30 Y Treasury Bond Futures, 10 Year On The Runs, 7 Year Interest Rate Swaps and LT US Treasury Bond Futures were all lowered by up to 19%. Good thing the move comes 4 weeks before the end of QE 2. Were it to just precede, or, gasp, coincide with June 30, one may get ideas that this is not quote unquote risk management, such as that expressly not exhibited by the CME's refusal to hike ES margins following their cut, but is nothing but another glaringly obvious means of directing speculative capital into preferred asset classes.

Today, very quietly, the Treasury released its latest refunding announcement, in which it disclosed it would issue another $66 billion in 3, 10 and 30 Year notes next week. The irony of course is that the US is and continues to be at its debt ceiling limit (or just $25 million short of it), at a total of $14,293,975 million. Furthermore, as was also disclosed by the Treasury, this gross issuance will also be the net amount added in marketable debt, as upon settlement on June 15, there will be no redemptions of maturing bonds. Which simply means that the continued "disinvesting" (which is merely a polite word for plundering) from intragovernmental debt, also known as retirement accounts, is about to kick into high gear. As a reminder, the only solution that Geithner currently has to run the government, at least until August 2 when even this runs out, is to slowly drain the debt in non-marketable accounts, in the form of Suspension of G-Fund and ESF reinvestments, as well as the Redemption and suspension of of CSRDF Investments, measure which when combined will provide a short-term buffer of $232 billion. Yet for all practical purposes, what is happening is that retirement accounts are now being seriously plundered, and if the unthinkable were to happen, and the debt ceiling would not rise, not only would the US be in technical default, but various retirement funds, which already are underfunded, would find themselves even more severely in the Red. As the chart below shows, the total amount of intragovernmental debt currently outstanding, has dropped to levels last seen in early April, even as total debt has continued its steadfast move higher. The scary thing is that by the time August 2 rolls around, the current total of $4.608 trillion in various Trust Funds, will drop to well about $4.4 trillion, or an implicit 6% underfunding in 2 months merely to keep the bloated government operating for a few more months.